Now is a good time for investors to ‘carry’

Yesterday’s capitulation by the Federal Reserve to stock market bears had surprisingly little impact on major equity indices. After a strong session yesterday afternoon, markets today were mixed, with stronger than expected earnings by Apple balanced by a miserable outlook from Dow-Dupont. The S&P 500 closed modestly higher, and the Dow-Jones Industrial Average modestly lower.

There isn’t any imminent event to drive the market higher during the next couple of weeks, and the Lunar New Year holiday in China couldn’t come at a more convenient moment. The Fed came, and saw, and was conquered by a market that threw up at the prospect of any sort of tightening, at which point Federal Reserve Chair Jerome Powell sounded very much like the late American comedian Groucho Marx: “Those are my principles! And if you don’t like them, I’ve got others.” There isn’t much more the Fed can do to reassure the market. The January bounce is what there is. There ain’t no more.

There isn’t likely to be any more news regarding a US-China trade settlement until late February when President Trump will in all likelihood meet Chinese President Xi Jinping. I continue to believe that the US and China will come up with some sort of package that Trump can advertise as a victory, but there’s nothing to trade on for the time being. Chinese equities have had a great run during January and are likely to pause.

US equities don’t look convincing after the January bounce. Expected returns to equities don’t quite justify the volatility.

The expected return numbers are based on Bloomberg’s survey of equity analysts, and I don’t believe some of them. Telecom in particular looks much too high. There’s a lot of consumer pushback against high costs from providers Verizon and AT&T, and the sector seems fragile to me.

In this unappetizing mix, the least objectionable is Consumer Staples (Proctor and Gamble, Coke, Pepsi, Wal-Mart, and so forth). The relevant ETF is XLP. The sector outperformed during the market crash of November and December and shows distinctly lower volatility than the market.

There’s a broader economic reason for the sector’s strength: the US economy, as I’ve noted before, continues to add jobs, and these jobs come overwhelmingly from small businesses. Most of the 200,000 or so that the US is creating each month are at the lower end of the pay scale (entertainment and leisure, health care), but the US workforce is growing at about 1.5% a year. Add a 3% rate of increase in hourly pay, and the consumption tailwind in the US economy is close to 5% in nominal terms. XLP pays a dividend of over 3%, and is unlikely to blow up.

Employment-driven growth is good for steady businesses like consumer staples, and also for real estate. Everybody’s got to be somewhere, and more employment means more office and apartment rentals. The price of US real estate investment trusts is about 40 times earnings, right around the long-term average. Competing income-earning assets like bonds, meanwhile, yield much less. It’s not compelling, but not the worst alternative.

I also like emerging market local-currency debt in this environment. An accommodative Fed is good for emerging market currencies, and most of the major issuers have cleaned up their balance sheets during the past few years. The JP Morgan Emerging Market Bond Fund (EMB) currently yields over 10%, and its price has risen from $103.7 to $108.6 during January.

In sum, it’s a coupon-clipper’s market. Most of the good news has been ingested and digested. The best risk-reward is in coupon-or dividend-paying securities with a reasonable degree of security.

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